RonCo Company is considering a recycling project.The project will result in a significant decrease in their garbage disposal costs.The acquisition cost of the recycling machine is $100,000.The present value of the depreciation tax shield (CCA)is $35,000 and the machine is expected to have a zero salvage value.The firm can lease the machine instead of buying it - the present value of the before-tax lease payments is $60,000 and the present value of the tax savings from the lease payments is $20,000.Should the firm lease the recycling machine and why or why not?
A)Yes, the net NPV of leasing is $60,000.
B)Yes, the net NPV of leasing is $25,000.
C)No, the net NPV of leasing is −$40,000.
D)No, the net NPV of leasing is −$175,000.

Question

Quizplus · Accepted Answer

To determine whether the firm should lease or buy the recycling machine, we need to calculate the net present value (NPV) of each option.

Buying the machine:
- Initial cash outflow: $100,000
- Tax savings from depreciation: $35,000
NPV of buying = -$65,000 (negative because there is a cash outflow)

Leasing the machine:
- Present value of lease payments: -$60,000 (negative because it's a cash outflow)
- Present value of tax savings from lease payments: $20,000
NPV of leasing = -$40,000 (negative because there is a cash outflow)

Comparing the two options, the NPV of leasing is less negative than the NPV of buying. Therefore, the firm should lease the recycling machine. Choice B, "Yes, the net NPV of leasing is $25,000" is the correct answer.

RonCo Company Is Considering a Recycling Project